I will be filing a form 3115 to claim depreciation not taken in prior years for a residential rental property. However, the taxpayer did not rent the property in 2018.

[danny]

Taxpayer moved back into the property in 2017 and it is their primary residence now.  They plan to live in the property as a primary residence until sale in 2020-2021 time frame.

Do I enter everything and carry forward the expense as a PAL until the sale frees it up?

[itonewbie · Accepted solution]

Agree with Mr. Smiley Guy that your client missed the boat for amending prior year returns.

Rev. Proc. 2018-31 Section 6.07 does provide relief and considers the year of disposition as the "year of change", where the change is from an impermissible method of accounting for depreciation to a permissible method of accounting for depreciation (which includes a change from treating an asset as nondepreciable to depreciable in accordance with the tax law).

Since depreciation allowable must be taken into account in the determination of gain regardless, the filing of F.3115 will not directly change the amount of gain that needs to be recognized but it could because a §481 adjustment will be allowed (without the need to adjust any suspended PAL).

I would have to disagree with Bill though, that §121 exclusion CAN be applied against depreciation that was never actually taken on the basis §121(d)(6) refers to §1250(b)(3), which has the usual allowed or allowable provision.

[TaxGuyBill]

Hmmm.  You may be right about 6.07.  I have stuck in my head that it would not be allowed if it was currently being treated properly (such as claiming depreciation), but after re-reading it, I think you are right, it may be allowed.

[danny]

Thank you both very much.  Turns out this taxpayer rented it for 1/2 year in 2018 (not 2017) so there will be active rental activity to report on this year's return.  I will take all the depreciation as an Other Expense on this year's Sch E per the standard procedures when filing form 3115.

[TaxGuyBill]

I don't think you are allowed to do it.

Form 3115 is used for a "change" in accounting method, and the 'catching up' on depreciation is usually allowed because you go from an "impermissible method" (not claiming depreciation) to a "permissible" method (claiming depreciation).

If it was not rented in 2018, depreciation is not "permissible" in 2018, so there is no "change" to use Form 3115 for.

There is a slightly more lenient rule in the year of the sale, but I still don't think it will be allowed for the same reason I explained above.

As a side note:  Whenever the property is sold, there will be "Nonqualified Use" for purposes of the $250,000/$500,000 exclusion.  That prorates the allowed exclusion.

Although the $250,000/$500,000 exclusion does not apply to depreciation that was taken, it CAN be applied for depreciation that was never actually taken.  So the unclaimed depreciation will still lower the Basis of the home, but part of the might be canceled out by the prorated $250,000/$500,000 exclusion.